Interest Coverage Ratio

This ratio measures how comfortably a company can meet the interest payments on its debt. A higher ratio means a bigger cushion before interest payments become a strain.

For example, a company with EBIT of 400,000 and interest expense of 50,000 has an interest coverage ratio of 8. Its operating profit is eight times its interest bill.

A ratio below about 1.5 is often seen as a warning sign, because a modest fall in profits could leave the company unable to cover its interest. A ratio below 1 means operating profit does not cover interest at all, so the company must use cash reserves, sell assets or borrow more.

Some versions use EBITDA instead of EBIT in the numerator, giving a higher figure because depreciation and amortization are excluded.

Lenders and credit rating agencies use interest coverage to assess credit risk, and many loan agreements include a minimum required ratio. The ratio is particularly important when interest rates are rising, since higher rates increase interest expense and can quickly erode coverage for companies with large amounts of floating-rate debt.